Q: What Are the Different Types of Payroll Deductions?

Payroll deductions are money taken from an employee’s paycheck to pay for taxes, benefits, or other financial obligations (like wage garnishment for child support). If you’re setting up payroll for the first time, you’ll want to pay attention to the different types of payroll deductions.

If you need to calculate payroll deductions and take home for your employees, check out this Paycheck and Payroll Calculator

Not all payroll deductions are created or managed the same way. Here’s how to look out for them and what happens if you make a mistake.

Payroll deduction types

There are three main types of payroll deductions:

  • Pre-tax deductions and contributions
  • Local, state, and federal taxes
  • Post-tax deductions and contributions

Pre-tax deductions

A pre-tax deduction is money that is taken out of your employee’s gross pay before any taxes are withheld from their paycheck.

Pre-tax deductions reduce an employee’s taxable income, which means they will likely owe less income tax and/or FICA tax (which includes Social Security and Medicare).

Pre-tax deductions can also lower employer-paid taxes, like FUTA (the Federal Unemployment Tax), FICA, and SUI.

Not all pre-tax deductions are the same. Some deductions are considered pre-tax for all taxes, while others may still require certain taxes (like state taxes) to be withheld. Also, there are caps on some items in the pre-tax category. For example, the IRS caps how much can be contributed annually to a pre-tax 401(k) plan.

Common pre-tax deductions/contributions include:

  • Retirement funds. Contributions to some retirement funds like a traditional 401(k) can be a pre-tax deduction.
  • Health insurance. Health benefits, like health insurance or FSA or HSA plans, may allow pre-tax deductions. If your employee pays for health insurance through a health plan offered at your company, then those contributions could be pre-tax.
  • Commuter benefits. Some commuter benefits are eligible to be pre-tax deductions, within certain limitations.

Employee withholding taxes

Federal, state, and some local taxes are withheld from an employee’s pay on each paycheck. These can include:

  • Federal income tax
  • State income tax (in states where it’s required)
  • Any applicable local taxes at the city, county, or municipality level
  • Employee’s share of FICA (Medicare and Social Security taxes)
  • State disability insurance (SDI), if applicable

Post-tax deductions

A post-tax deduction is money that is taken out of your employee’s paycheck after all applicable taxes have been withheld.

Common post-tax deductions include:

  • Retirement funds. Some retirement funds are post-tax, like a Roth 401(k).
  • Wage garnishments. If your employee is subject to court-ordered garnishments, then those funds will be removed after their taxes have been withheld.
  • Union dues, charitable donations, and contributions to 529 college savings plans.

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Voluntary vs. Involuntary Deductions

Voluntary deductions are payroll deductions that employees choose to have taken out of their paycheck, like:

  • Retirement contributions
  • Health insurance
  • College savings plans

For the most part, life insurance is considered a personal expense and isn’t tax-deductible. But some employers make group term life insurance available to workers up to $50,000 in coverage for no extra charge. If employees want to add life insurance for a dependent, those funds are deducted from post-tax pay.

Involuntary deductions are required payroll deductions that must be taken out of an employee’s pay, including:

Wage garnishment is when a portion of an employee’s salary gets taken out to pay an outstanding debt. This includes child support, alimony, and loans that are very past due. The type of debt will determine how much is garnished. For instance, outstanding child support payments could garnish anywhere from 50% to 65% of your wages. Student loans will garnish up to 15% of your wages. All wages—salary, commissions, and bonuses—are included in garnishment calculations.

How states impact deductions

While there are 42 states that require state income taxes, not all of them are managed the same way. For instance, New Hampshire taxes dividend and interest income, while the rest tax wage and salary income. Some states have single-rate tax structures while Hawaii has 12 tax brackets. 

Where you live and how much you earn matters to how much you pay in state taxes. For an example of where payroll deductions appear on paychecks (including state taxes), watch the video below:

In the sample pay stub below, you can see which taxes are specific to the state. In this case the state taxes are for California.

Gusto employee paycheck pay stub example

Watch out for mistakes

Filing payroll and staying up-to-date on taxes is already enough work, so it’s no surprise that mistakes are common. If you don’t pay close attention, it could cost you. With almost half of small business owners handling payroll solutions themselves, it’s a good idea to know what to do if you run into a snag. Common snags include:

Making a payroll mistake. This could be underpaying an employee, overpaying, or not including paid time off or vacation hours. You can correct the error by issuing a check in between pay periods or correcting the mistake on the next pay run.

Missing payroll deadlines. You could face penalties, fees, and a host of other issues with your employees if you don’t pay on time. To avoid these, make sure you carve out time in your schedule to run payroll on your designated days. Set a calendar reminder, email reminder, or whatever else you need to stay on course.

Misclassifying employees. Hourly, salary, staff, contractors, part-time, full-time—not all employees are compensated the same way. Misclassifying an employee could deny them certain benefits and in some cases, result in underpaying them.

Remember, you don’t have to calculate all this information on your own. Calculating a paycheck can get tricky, so it’s always best to consult a CPA or use a payroll provider to make sure everything is deducted correctly.

How and when do employers report deductions?

Each form you complete comes with its own filing deadline, but they’re typically due quarterly or annually. Deductions are reported through a few different forms, including:

  • Form 940: FUTA. While both workers and employers pay unemployment tax, only employers complete the FUTA form. 
  • Form 941: Employer’s Quarterly Federal Tax. This form outlines how much federal income, Social Security, and Medicare taxes were withheld from employees every quarter. It’s required filing for almost every U.S. employee. Sometimes, you might need to complete Form 944 instead.
  • Form 944: Employer’s Annual Federal Tax Return. This is for small employers who have $1,000 or less in withholdings every year and pay those annually instead of quarterly.

Workers will complete their withholdings information through a W-4 form. These forms can be updated any time workers go through a qualifying event, like have a child or buy a home. When starting a new job, workers must say how much they want their employer to deduct from each paycheck. If you’re onboarding a new employee and they get stuck on how much to withhold, the IRS has a calculator to estimate the right deductions. 

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Comments

  • Cynthia D Blair

    I have an employee who is having $5 deducted from his pay for the benefit of a food bank. Does Gusto remit that to the food bank or does the company? I have the payroll integrated with QuickBooks Online and the deduction isn’t reflected in the liabilities. Where did it go?

    Reply
    • Gusto Editors

      Hi Cynthia, if your employee is donating via Gusto Giving, Gusto will remit to the charity of their choice. If you have any further questions, we recommend you reach out to our support team via the Help tab in your Gusto account, as that will be the best way to get your question fully answered.

      Reply
  • Betina Cochran

    Hi. I would like to set up a Christmas Club account with my bank. Do I set that up as a recurring custom deduction in Gusto??

    Reply
    • Gusto Editors

      Hi Betina — if you’re interested in creating a savings account, you can look into using our Gusto Wallet app (free) to use our paycheck splitter to automatically route your paycheck into different accounts. If you have any further questions, we recommend you reach out to [email protected].

      Reply
  • Jessica T Allison

    Hi, I’m a 30-year-old nurse. I am able to choose whether I want to do pre-tax or post-tax deductions for my retirement plan. Which is better? I’m having a hard time deciding which is more beneficial in the long run.

    Reply
    • Gusto Editors

      Hi Jessica — we recommend you reach out to a CPA for specific guidance on your situation! We cannot offer legal advice through this medium.

      Reply
  • Ashley Webb

    If ur wages are garnished how much are they allowed or able to take out?

    Reply
    • Gusto Editors

      Hi Ashley, since tax rules can vary by location or industry, we recommend talking to a CPA or tax advisor for specific guidance!

      Reply

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